Author Topic: Investing in your company.  (Read 542 times)

COEE

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Investing in your company.
« on: September 06, 2017, 08:50:44 AM »
I am an engineer interviewing with a tech company and was talking with the CEO about business growth and his plan for near-term growth.  He mentioned that he was thinking about pursuing an angel investor or investors.

I am very interested in this company.  Many employees have been there for 15+ years, and they have been through some tough times, but the current CEO has taken a rocky company and made it a solid company - having made a profit in 93% of quarters since he took over.  The company is privately held and has been in business for 20 something years.  And with my potential hire will be at around 22 employees.  He is looking for what I'd consider a small amount of angel investment (in the $300k - $500k range) to finish bringing up a product line. 

I'm wondering if it makes sense to suggest maybe taking on employee investing.  I have a nice chunk of cash ($15-30k) that I could easily invest in the company and make my money back in relatively short order based on salary alone.  Assuming that he pays back his loans with interest, in 4-5 years or less, does it make sense to even mention this option to him.  I'm sure he's thought of it - but maybe offering up some of my cash right away might convince him to give me a yet higher salary.

Most of the employees are more experienced engineers (and mustachian based on the lineup of cars in the parking lot) and perhaps he can raise all of the money within, providing extra incentive for employees to perform as well. A bit of a win-win.

Is this a dumb idea? 

Is this even legal?  What is the difficulties?  SEC oversight?  Does this involve the employees buying shares?  How would the company be valued?  I.E. How would this work?


zephyr911

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Re: Investing in your company.
« Reply #1 on: September 06, 2017, 09:25:49 AM »
Is this a dumb idea? 
Only if it doesn't work. It's high risk with potential high returns. Allocate accordingly, but do your due diligence.
In my time following MMM, I have gone from mostly indices to almost exclusively single stocks, and whether there are actual shares here, this idea his highly analogous to a single-stock investment, since it's an ownership interest in one company. Your risk goes up and your returns may or may not. There are many questions that only you can answer, and it will take time. Whatever you do, don't rush in... false urgency is your enemy. Ask questions, ask more questions, ask follow-up questions. Anyone who values your capital will appreciate the due diligence and respond in good faith.
I have had many meetings over the course of months just to secure a few thousand in funding for my startup. I'm not saying to intentionally drag things out, but definitely take as long as it takes to answer every question you have. If it's all above board, they will appreciate the questions and be forthcoming about the answers. If they have a problem with it, HUGE red flag.
To some of your other questions:
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Is this even legal?
Is what legal?
Employees investing in a company is almost always legal. A company selling securities (shares, bonds, etc) without registering them is most definitely not. But you can invest in a company without it selling securities. That's where the EXACT "what" is everything. Figure that out, and you can probably tell if it's legal.
I have an LLC for real estate investments, and I'm accepting new members (co-owners), which is easy and simple to do, legally. The bylaws specify the requirements, expectations, and risk mitigation measures that apply to each new member's investment, along with expected performance and several "what ifs" like what happens if you want your money back and the company is broke. The contract each new members signs requires them to understand and agree to those conditions, and also requires the company to acknowledge its responsibility for meeting performance goals or to use various backup options (like borrowing money or selling assets) to mitigate their losses and provide at least some return before I ever get anything. I would expect something like that from this company.
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What is the difficulties?
Lack of liquidity is a big one with small companies. They're going to invest your money, so they can't just buy your ownership interest back if you decide you want out, and maybe nobody else wants to buy when you want to sell. You might have to take a huge discount on actual value, if you can even sell at all.
Another big one is difficulty in precisely valuing the company or your piece of it, especially if it has no clear and simple share structure.
Another major concern could be a lack of transparency, if the company's finances are handled internally and not subject to independent audits. I hired a CPA for my startup long before I actually needed one for that reason, and will add third-party audits as soon as we can afford them, because that is one of the best ways to ensure nobody's skimming or faking profitability and I want to inspire maximum confidence among any potential investors.
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SEC oversight?
Not unless it's publicly traded, and at 22 employees, that's highly unlikely.
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Does this involve the employees buying shares?
It doesn't have to, but it could and probably should. Otherwise, your stake would have to be measured as a percentage of ownership, and every new buy-in would require a recalculation of everyone's percentages. It's an exponential nightmare in accounting.
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How would the company be valued?  I.E. How would this work?
You can calculate value a lot of ways. Book value is easiest, and if they have a CPA they are calculating this fairly often. Calculating net present value based on projected earnings growth is a bit more complex but can potentially demonstrate a higher current value than book value for a healthy, growing company. I would ask the CEO (or CFO or CPA) to tell you what they believe the answer is, and also what method they applied. Make them show their work so you can check it!
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Side note: you could also just offer to be a creditor to the company - make loans to it instead of buying an ownership interest. Just a thought. That puts you higher in the typical capital stack than a part-owner, and might give a more secure but potentially lower return. Me, I always prefer to own common stock or the equivalent. Young, high-earning, low-spending people like this forum attracts will usually do better by accepting a lower position in the stack, higher risks, occasional losses, and the lion's share of the rewards.
« Last Edit: September 06, 2017, 09:34:02 AM by zephyr911 »
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zephyr911

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Re: Investing in your company.
« Reply #2 on: September 06, 2017, 09:34:51 AM »
Sorry for all the damn edits, but I keep thinking of better ways to phrase things.
I hope nobody's been trying to reply.
I may be off WRT some finer points here but I'm sure someone will catch any raging FUBARs.
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SeattleCPA

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Re: Investing in your company.
« Reply #3 on: September 06, 2017, 09:47:11 AM »
I am all for investing in small businesses... few people are bigger boosters of the idea.

But this situation seems really tricky to get right. So many pieces to fit together:
1. The valuation needs to be right and fair. (Normally, small businesses are 2-5 times cash earnings.)
2. The liquidity exit needs to work. (I.e., how do you ultimately get your money out of the deal.)
3. Are you sure at this point that management knows what they're doing? In many small businesses, this would be an optimistic assumption.)
4. Are you sure the majority shareholders feel a strong duty to make this investment work well for the minority shareholders?
5. Is this too much financial risk for you and your family to bear? I.e., you've got an awful lot riding on this one horse someone else holds the reins of.
6. Why does this small business need capital? Many small businesses you'd want to invest in--if given the chance--will generate enough internal profit to fund their own growth... and if that's not the case, hmmmmm.

BTW, if you want to bear risks and enjoy rewards of small business investment, I'm all in. But something you have more control over seems a lot, lot better.
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Interest Compound

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Re: Investing in your company.
« Reply #4 on: September 06, 2017, 09:48:58 AM »
The fact that this company also employs you, makes it even more risky. If the company fails, not only do you lose your investment, you lose your salary too.

It's typically recommended not to invest more than 5% of your portfolio in speculative plays like this. Does $15,000-$30,000 represent more than 5% of your portfolio? If so, I wouldn't do it.

Passive investing has a deep humility at its core--the aim is not to separate winners from losers, but rather to hold the entire market. Volatility is only temporary, but you can permanently cripple your portfolio trying to avoid it.

moof

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Re: Investing in your company.
« Reply #5 on: September 06, 2017, 11:52:14 AM »
Don't eat where you crap.

Heckler

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Re: Investing in your company.
« Reply #6 on: September 06, 2017, 12:02:32 PM »
Hell no.  Getting the next paycheck is risky enough in my business.

zephyr911

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Re: Investing in your company.
« Reply #7 on: September 06, 2017, 01:19:37 PM »
It's typically recommended not to invest more than 5% of your portfolio in speculative plays like this. Does $15,000-$30,000 represent more than 5% of your portfolio? If so, I wouldn't do it.
I would agree with this.

Most of the other comments are a bit broad-brush for my taste. Being an owner and being an employee are perfectly compatible. In fact, insider ownership (officers owning/buying shares) is widely regarded as a positive metric of a publicly traded company's health. As a new employee, you're not privy to the kind of details that those people have, but you might eventually gain sufficient access to make an informed decision.

I agree with the rest, and even said myself, that this is a high-risk idea, but risk tolerance is personal and depends on your values, goals, priorities, overall financial situation, and other factors. In summary, again, ask a lot of questions and never rush to decide. If they take issue with either of those points, run the other way. And maybe run the other way regardless. But these kinds of things are often the most lucrative investments precisely because most people are afraid to try it.
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COEE

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Re: Investing in your company.
« Reply #8 on: September 07, 2017, 02:16:47 PM »
Thanks for all of the replies.  I probably won't address everything, but you all have certainly left me with plenty to think about.

Some clarification - the amount I would put up would be a small portion of my net worth - I don't want to give exact numbers.  Right now I hold this in cash as part of my emergency fund - so it's doing nothing for me right now - and I believe the chances of needing all of that fund immediately after joining a company are small.  My potential salary increase will more than make up the difference in a year or two.  It just seems to me like it may be possible with this company to seek the "angel investors" from within the company.  Really $0.5M isn't that much for a business and engineers are paid well.

I'd be more interested in a loan than buying shares of the company - because I know the volatility of small business.  Something I can get a decent rate back on would be good, unfortunately I think getting a business loan may be better.  But if I could get a (mostly) guaranteed 7-9% back on my money, I'd be happy.

I am all for investing in small businesses... few people are bigger boosters of the idea.

But this situation seems really tricky to get right. So many pieces to fit together:
1. The valuation needs to be right and fair. (Normally, small businesses are 2-5 times cash earnings.)
2. The liquidity exit needs to work. (I.e., how do you ultimately get your money out of the deal.)
3. Are you sure at this point that management knows what they're doing? In many small businesses, this would be an optimistic assumption.)
4. Are you sure the majority shareholders feel a strong duty to make this investment work well for the minority shareholders?
5. Is this too much financial risk for you and your family to bear? I.e., you've got an awful lot riding on this one horse someone else holds the reins of.
6. Why does this small business need capital? Many small businesses you'd want to invest in--if given the chance--will generate enough internal profit to fund their own growth... and if that's not the case, hmmmmm.

BTW, if you want to bear risks and enjoy rewards of small business investment, I'm all in. But something you have more control over seems a lot, lot better.

2 - that's why I'd prefer a loan over a stock purchase.
3&4 - I don't have a ton of confidence, so I'd of course want to do some more homework.
6 - This is a great question.  I think the company believes they can fund the project without a problem, but they want to expedite the process of bringing up the product line.  That's what I got out of our brief conversation anyway.

Most of the other comments are a bit broad-brush for my taste. Being an owner and being an employee are perfectly compatible. In fact, insider ownership (officers owning/buying shares) is widely regarded as a positive metric of a publicly traded company's health. As a new employee, you're not privy to the kind of details that those people have, but you might eventually gain sufficient access to make an informed decision.

I agree, I would like to know more about the company before doing anything I'd regret - and some of the comments are a bit 'broad-brush' as you put it.  I'm always looking for ways to make money.  Sometimes I win, sometimes I lose.

surfhb

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Re: Investing in your company.
« Reply #9 on: September 07, 2017, 05:00:16 PM »
You are already invested in the company by working there.   

Diversification is key to good investing.

Lonely Artisan

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Re: Investing in your company.
« Reply #10 on: September 07, 2017, 08:00:20 PM »
As a minority shareholder in a private company for some years and been in multiple deals like this I can say at least the following

- Get a good business lawyer to help you through the process.... they can save you from making costly oversights... but do not forget following point:

- The lawyer costs associated with drafting the letter of intent, due diligence, revisions and eventually transaction fees should be included in the evaluation of the return on investment. This is especially true if there is no structure nor framework to share buying or dilution. From someone starting with nothing of that 15-20K in legal fees would be a minimum so think it through of have the company pay

- Review your rights and liabilities in the shareholder agreement as a minority shareholder. You could get lead in many situatin where you have more at stake than you though. Now the company is 3x profitable and the owner wants to diversify in a testicule waxing franchise? How are you gonna stop your money from being dumped into that gold mine? What voice do you have in the company, to what documents you have access to monitor your investments. Do you sit on the board? How do they vote? How do you oppose? Is the owner a majority stakeholder by himself? Do not think you will see always eye to eye, and moreso if things go sour for a while.

- Back to the shareholder agreement... it is the most important document to enshrine the rules of the game... read up on standard clauses like right to first refusal, piggypacking and shotgun clauses etc...

- Think about your exit strategy early. How others have exited? How could you get ejected? Do you have other to band with? How much of value (disposable) are you or your "band" to the majority shareholders? Are "management gangs" going to form along different viewpoints?

- Is the current owners following your management style? Are they rigourous book keepers or more cowboys/mavericks kinds? Will they submit to questions and requests by minority shareholders or just ignore them?

- Think about getting enough insurance, especially if you are on the board as there are liabilities involved that you need to be aware of

- How is the EBITDA and the resulting dividends redistributed? Is it contractually binding? If so there is a basis for a better ROI calculation. If not then you might never see a penny.

- How are the dividends paid out? There are fiscal implications here, your personal rate vs holding them via a holding company would be different.. again an accountant here is helpful

- As for valuation for me the dividends should pay back the initial investment within 5 years... then going on the dividens pay out historically work out the valuation. Much easier as the revenues, which can't be debated, result in the valuation. There is a lot less negotiation then, which is a risk to the business relationship.

- Also you'll be a LOT more involved, not always by choice, into internal politics because of your perceived status as part owner.

It could be very case specific but it can definitely change the nature of how you relate to your work. There is a lot of empowerement to feeling "the boss", but it also changes the way the other employee see you even if nothing has changed except you taking on more risk for great potential payouts.

That's about it. PM me if you have questions
« Last Edit: September 07, 2017, 08:03:29 PM by Lonely Artisan »

MaaS

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Re: Investing in your company.
« Reply #11 on: September 07, 2017, 09:09:17 PM »
Seems like it could introduce some odd dynamics.

No idea what you should do.  I wouldn't do it. 

Retire-Canada

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Re: Investing in your company.
« Reply #12 on: September 08, 2017, 08:10:20 AM »
Is this a dumb idea? 

Not dumb as in moronic, but dumb as in not something you should be worrying about. You are not hired yet and when you are you are being hired to be an engineer. So engineer the shit out of it and let the CEO/CFO/etc... worry about funding the company's operations.

There are smarter and safer ways to get your EF cash working for you if that's your real concern.

Personally I hate it when you hire someone new and they get their nose into stuff they were not hired for as if they suddenly have it all figured out and like nobody else whose job the task actually is has thought about something obvious. It's super annoying. So my advice....don't be "that guy".
« Last Edit: September 08, 2017, 08:11:51 AM by Retire-Canada »